Zombie Directors Should Exit U.S. Boardrooms

By Nell Minow -
Jul 18, 2012

When I testify before Congress about
corporate governance, I like to watch the faces of the committee
members when I explain the rules for electing corporate
directors. “I know you, better than anyone else, understand what
the word ‘election’ means,” I say. “Well, in the wacky world of
public corporations, you win even if 99 percent of the
shareholders vote against you.”

Except for the fraction of cases where someone nominates a
competing slate of candidates and undertakes the multimillion-
dollar expense of a proxy contest, management’s nominees are
routinely elected to the board. Dozens of directors continue to
serve, like boardroom zombies, even after a majority of the
shareholders voted against them. In the past three years, about
200 directors failed to receive majority votes. Almost all of
them continued as board members.

Some companies have responded to shareholders by
voluntarily adopting a policy requiring directors who get less
than a 50 percent vote to submit their resignations. Even that
doesn’t necessarily mean directors must leave the board. In
2005, when Blockbuster’s chief executive officer was ousted by
shareholders in a proxy contest, the directors created an extra
board position and voted him back on to ensure “continuity.” It
seems continuity was exactly what the shareholders were voting
against. They were right; the stock continued to sink and, after
the company declared bankruptcy in 2010, its assets were
acquired by Dish Network Corp. for a song.

Checks and Balances

The genius of the corporate structure is the checks and
balances that are supposed to make sure the interests of the
providers of capital and the managers who spend it are aligned.
The responsibility for that alignment is so important that the
legal system imposes the highest level of care and loyalty, the
fiduciary standard, on boards. That means directors must act for
the benefit of shareholders, setting aside their personal
interests. It doesn’t mean much if shareholders can’t replace
directors who fail to meet the standard. Edward Jay Epstein, an
investigative journalist, has said that director elections are
“procedurally more akin to elections held by the Communist party
of North Korea than those held in Western democracies.” Board
candidates are selected by insiders (usually the CEO) and almost
never have any opposition. Once picked, directors serve at the
CEO’s pleasure -- a structure that at best discourages
independent oversight and at worst thwarts it entirely.

No one is suggesting that director elections should
resemble political elections, with open, contested seats. Still,
there has to be some fallback mechanism short of a full-scale
proxy contest with a dissident slate to oppose management’s
choices. Here’s an idea: Most U.S. public-company stock is held
by an assortment of institutional investors, including mutual
funds and pension funds. If more than 50 percent of them agree
that it is time for directors to go, they should go.

I once met with the chairman of a board nominating
committee at a large, troubled company to talk about the
procedures and criteria for selecting candidates for three
openings. He explained that they didn’t have to look for anyone
because all the current directors wanted to stay on. That isn’t
how it’s supposed to work. Boards should continually evaluate
their own performance to make sure all of the directors are
fully engaged and capable, and that the board has the range of
expertise and experience it needs.

We have come a long way since my first years in this field,
when O.J. Simpson served on five public company boards
(including one audit committee) and the CEOs of Inland Steel Co.
and Cummins Inc. led each other’s compensation committees. But
the reality is that there can be no meaningful independence on
the board if a majority vote of the shareholders has no
consequence.

Spineless Decision

It is risky and foolish for boards to retain directors
rejected by the shareholders. Despite a spineless decision in
November by the American Bar Association’s Corporate Laws
Committee to decline to recommend that majority votes be
required for directors, boards must recognize that they can’t
retain zombie directors who serve without the support of
shareholders.

I suspect the most powerful push won’t come from
shareholders but from the providers of liability insurance for
directors and officers. The law protecting them from personal or
corporate liability for business failures gives deference to
“business judgment.” That means if directors demonstrate care
(doing their homework, participating in the meetings) and
loyalty (making decisions on behalf of long-term shareholder
value and not insider enrichment), the courts won’t second-guess
their decisions by holding them liable, even in the case of
“mistakes or errors in the exercise of honest business
judgment.”

The business-judgment rule, however, is predicated on the
assumption that shareholders delegated authority to directors by
electing them, and could elect others if they chose. It is hard
to imagine that the courts would grant business-judgment
protection to directors who received a vote of no-confidence by
shareholders. Like in the classic children’s book by Dr. Seuss,
when shareholders tell Marvin K. Mooney that he should go now,
boards should take heed.

(Nell Minow, the co-founder and director of GMI Ratings,
which evaluates governance risk at public companies, is co-
author of the textbook, “Corporate Governance,” now in its fifth
edition. This is the second in a three-part series on corporate
governance issues. Read Part 1. The opinions expressed are her
own.)